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Preference (Preferred) Shares & Equity Shares - Types of Shares | #8 MASTER INVESTOR - YouTube
Channel: Asset Yogi
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Namaskar, my name is Mukul and welcome to Asset Yogi.
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Friends, in many of my previous videos
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I've talked about common liquidity shares and preference shares.
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So, many of you asked what's the difference between both of them
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So, in this video, we are going to learn that difference only
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like for example, why preference shares are called preference shares?
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that means some kind of priority is given to them
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so what kind of priority is given?
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What sorts of returns do we get in both of them?
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What kind of risks are involved in both shareholding?
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Which type of investor invests in equity shares or preference shares?
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Why does any company raise money from equity shares or preference shares?
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We will try to find the answers to all such queries from this video.
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So, do watch this video till the end.
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Let's go straight to the blackboard.
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Let's understand equity shares and preference shares with the help of an eg.
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Preference shares and Equity shares come into the picture
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when any company raises money from the market.
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As we have talked earlier, money is raised from the market by two ways
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whether a company can take a loan/debt
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and second money can be raised using equity shares.
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Let's assume there's no chance this company can get a loan
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or a company doesn't want to take a loan.
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It wants to raise money by equity only.
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So, in that case, what are options available for it ?
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Let's say this company is worth 10 crores.
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Now, it divides this 10 crore into shares.
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Now, the total ownership of the company will be divided into shares.
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So, which type of share holders are inside it?
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One is your owners
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Let's say promoters want to keep 50% ownership with themselves.
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That means their share holding will be worth 5 crores.
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and they say, they want to raise the rest of the money by common share holders
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that means, let's say 35% i.e 35 crores they want to share by common share investors
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Thirdly, they say 15% i.e.1.5 crores they will issue preference shares.
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So, these two types of shareholding,
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investors' money and common share investors' money
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by combining them, we call it Equity Shares
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or Ordinary Shares.
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and the second type is preference share investors
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so one is your equity share investors and second is your preference share investors.
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Now, in both types of shareholding, there's some difference in their rights
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and what are its benefits and losses?
Let's discuss them.
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Let's suppose, he is Rahul and he has invested in preference shares
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of that company.
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So, he is the preference share investor.
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On the second side, Sandeep is the equity shareholder of the same company.
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So, What would be the differences between their rights?
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First of all, the dividend is fixed promised to the preference share investors.
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Preference shares, they work just like bonds or debentures.
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We pay fixed interests in bonds
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Let's say if we made a promise of 11% to the investor
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so, in preference share, we have to give quite high returns.
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So, let's say 14% returns are promised here.
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On the other hand, equity share dividend's are not promised
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the company declare the dividend as per the profit made by the company
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and if a company wishes, or if it's the company's policy to not give dividends
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so no need to give a dividend then
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because equity shareholders main profit is from shares' price.
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As the share price increases or decreases so is the profit of the investors affects.
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But here, there's no effect of the shares' price over the preference share investors.
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We will discuss it in a bit more detail.
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So here, why are they called preference shares?
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mainly because of two reasons
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First is the preference right.
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when dividend's payment is made at that time preference shares are the priority
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when the company gets profit after paying tax, that means, Profit After Tax
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In that, dividends are paid first to preference shareholders.
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so these 14% dividends will be paid first
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equity share holders get their return only after preference share holders
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whether we take it as a dividend form or take it as the increase in share's price
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so here these dividends are fixed
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these are promised first, that's why we call them preference shares.
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And the second preference right comes, when
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if the company comes at the verge of being bankrupt, business has to wind-up
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so the money that you'll get after auctioning the assets
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in that equity share holders are paid before preference share holders
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and equity share holders come at last
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Let me write down the priority here.
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First comes the number of loans and bonds
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on second, preference share comes
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and third comes the equity share holders.
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But, pay a little more attention to it, when
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a company is on the verge of bankruptcy, its bonds and loans are very high.
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So, because of this only loans and bonds creditors are paid
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preference share holders and equity share holders
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don't even get money in 90% of the cases.
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So, in a way, we can say that preference shareholders are not much benefitted here
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because in case of bankruptcy, hardly
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preference shareholders or equity shareholders are going to get the money
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What else is the difference between preference shares and equity shares?
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In the stock market, preference share is not traded.
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Equity shares are definitely traded.
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And from here only, equity shareholders get their main returns.
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So, share price increases or decreases there's no impact on preference shares
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because their returns are fixed.
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They only care about the dividend.
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whereas equity shareholders are directly impacted.
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If share price, let's say it becomes 150 from 100
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then straight 50% returns are there
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But here, as we've seen, their dividends were promised at 14%
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but there are risks involved for equity shareholders
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if from 100, this share reduces to 80, then returns will be of -20% which is a loss.
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That's why on risk vs returns, we can say that,
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there's a lesser risk for preference shares because they are getting fixed returns.
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Equity shareholder's risks are higher because
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their returns are directly linked to the company's profit
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or are linked to share prices.
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Now, let's talk about management and control
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there are no voting rights for preference shares.
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Generally, voting is done to select the board of directors
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so preference shares do not get any voting rights.
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Equity shareholders are the ones who vote for the selection of the board of directors.
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Moreover, preference shareholders can't be a part of the management
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Equity shareholders can be a part of the management.
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What else is different?
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We've already talked about ownership and control
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that preference shareholders are co-owners
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because they are a part of equity shareholding
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but they do not have any control.
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Equity Shareholders are co-owners as well as they control the company
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however small the shareholder is, he /she will still have the voting right
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to choose the board of directors.
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Now, which kind of people invest in preference share?
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For people like you and me who are retail investors
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this option is generally not available.
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Here generally, financial institutions invest
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wealthy individuals invest,
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some family offices of wealthy individuals invest
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And many times venture capitalists or private equility firms invest in these shares.
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For people like you and me, for retail investors generally
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there's only an option of equity shareholding
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and institutional investors also participate in equity sharing
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like mutual funds, pension funds or any other institutional investor.
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Now, what are the exit options for reference shareholders?
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Suppose there's any wealthy individual or a financial institution
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if he buys the preference share then how can he take exit from that company?
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The first option is that the company can buyback if given an option
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and many times there's an option in preference shares that
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it can be converted into common equity.
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If converted on common equity once, then it can be sold in the stock market.
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Now, what are the options for equity shareholders?
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first is shares can be sold in the stock market
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the second option, the company also buyback the shares sometimes
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so broadly, this is the difference between preference shares and equity shares.
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Now, the question arises,
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why does any company raise money from preference shares or equity shares?
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Let's first talk about equity shares.
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When any company takes high debt or takes a huge amount of loan
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so there's a solvency risk for it.
Any bank will hesitate to give it a loan.
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Whatever investors will be there,
if the debt becomes very high
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then maybe the investors will not invest in the company.
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Therefore, to maintain a balance equity fundraising is done.
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Second, there's also an advantage of the company that if any hard time comes
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company's downturn comes, profit starts decreasing, then
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they do not have to give any fixed returns to equity shareholders
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like in debt, let's assume the company has taken a loan at 12% then it is fixed.
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This much amount of money has to be given.
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But returns are not promised to equity investors.
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Equity shareholders already know that it is a risky investment.
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Thirdly, debt risks can be reduced too much
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if debt increases too much then the risk of bankruptcy also increases very much
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if the business goes down even a little
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if the company start making losses
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then you have to give money to the bank
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but there's no need to give money to equity shareholders.
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So, in a way, the company reduces its solvency risk.
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So now, if the company can raise all the money from equity shares only
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then what is the need to issue preference shares?
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So here also,
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the first point is same that the company doesn't want to raise its debt funding
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the company doesn't want to increase its solvency risk.
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Second, the company has the option to not give the dividend payment
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or it can delay also
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there's no 100% promise
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because preference share investor is also a kind of equity investor
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he is also a kind of owner and he is also taking a risk
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So here, if I talk about risk, then in bonds and loans
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there's a very low risk for the investor.
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After that, we can say that there's a preference share risk.
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After that, if we talk about risk at the top for investors
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then the risk for equity investors is highest.
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So, in a way, these preference shareholders
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these come between loans and equity shareholders.
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What is the third advantage of preference shares?
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That the company can also buy back these shares
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if it wants to keep its ownership with itself.
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So, it can give an option to buy back also.
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At whatever price it had issued, it can also buy back at the same price.
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So, I think you must've understood
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what's the major difference between preference shares and equity shares
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after watching the video.
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In the next video, we will see how many types of preference shares are there?
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So, that's all in this video.
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If you want to share your views about this video or this channel
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so you can do that in the comment section below.
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In fact, you can also suggest topics for future videos.
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If you like this video then do like and share it.
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So see you in the next video,
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till then keep learning, keep earning and be happy as always.
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